October 22, 2019

Distressed Investors: Winter is Coming

Maybe the Game of Thrones references have all been played out (perhaps I should instead be quoting the Roy family from my newest obsession, HBO’s “Succession” series). Nonetheless, the messaging I’m getting from some very smart corners of the distressed investing landscape is that we’re in the late innings of the bull market run up… and they’re preparing accordingly.

Over the last 4 months, I’ve received multiple outreaches from savvy distressed investors who are looking to bring some operational expertise in house.  In many cases, when the markets turn, they find themselves in (quasi) control positions on struggling companies where the other equity owners look to them to step in and stop the bleeding.  Banks will look to GPs to execute some sort of value creation plan because they’re certainly not in any position to engineer one themselves.  Thus the idea of an Operating Partner takes on momentum, and a new class of opportunity emerges for those of you interested to consider them.

That being said, there are some significant differences in the way an Ops Partner spends his/her time if we compare a traditional PE shop with a distressed investor.  Traditionally of course, an Operating Partner is working on a more manageable number of companies so they can spend enough time inside to actually deliver some tangible results.  In the distressed setting, the Ops Partner may find themselves doing something more akin to portfolio management.  There needs to be a rational look at the businesses and some hard decisions about priorities must be made.  

A seasoned investor said to me years ago (before the notion of Operating Partners really institutionalized itself across the asset class) that he worried that to an Operating Partner everything might seem fixable.  In his estimation, there needed to be more discipline around letting some companies die. “It might feel good turning a D to a C- but it’s a dumb way to spend time as far as I’m concerned.”   

In the distressed setting, an Ops Partner needs to be very judicious about where they spend their time.  It’s highly unlikely that anything that finds itself in the hands of a group of creditors is going to turn itself into a 5 bagger. So the Operating Partner in this context needs to have a little bit more of a deal mentality than we’d otherwise see in a more traditional condition.  Of course, there will be an amplified focus on cash flow…. and on existing management.  How quickly should we move to sack the CEO?  Time is definitely working against the owners when the market forces turn, and their options for calming the water are much more limited.  

There’s a chance for a silver lining in every negative market turn.  In this case, for someone seeking a role inside the tent of a distressed investor, more operating focused roles will emerge.  This is a good thing and provides a wonderful proving ground.  That being said, over the last 6+ years I have seen middle market growth focused investors (who’ve been riding high for a long time now) scoff at the idea that someone from a distressed shop could transition into their environment and become a growth focused resource.  As such, think hard about the longer term implications of moving to the distressed side particularly if it’s not exactly who you are. 



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